Alphabet (GOOG, Financial)(GOOGL, Financial) grew its core search revenues +18% (foreign exchange adjusted) on a staggering +68% year ago comparison. Despite this stellar top-line performance, shares continued to sell off as the market discounted fears of a recession. Our multi-year time horizon allows us to tolerate this exact kind of short-term volatility in growth rates (rather than implicitly extrapolating near-term slowing growth trends into perpetuity by selling). The past few years of economic activity and dramatic shift in company-specific drivers of growth have been unprecedented, so a “normalization” of end-market demand at Alphabet is not the end of the world in terms of surprises. In addition, core Google Search has been less affected by disruptions related to Apple’s privacy initiatives thanks to the Company’s long-term investment in the Android Mobile operating system. Alphabet’s Cloud segment is generating revenue at a $25 billion run rate, but is still running at a loss. This business is capable of generating much better margins at some point. In the meantime, the Company has a fortress balance sheet and has been repurchasing shares at attractive historical multiples.
Alphabet
Alphabet’s business segmentation has been gradually broken out over the past few years and often it seems most of the discussion about the Company’s segment performance revolves around YouTube, Google Cloud Services, and even the Company’s Other Bets. But the standout performer of the Company’s segments over the past few years has been “Google Search & other.” The ignominious descriptor of “other” is used in more than a couple of Alphabet’s named segments, but in the case of Search, “other” contains the revenues from no less than: Google Maps, Gmail, and Google Play. These “other” businesses along with Search have generated an incremental $50 billion in revenue since the pandemic emerged.
Gmail is an 18-year-old, nearly ubiquitous service utilized by over 1.5 billion users every day.2 During the pandemic, this service became even more important as digital communication supplanted office interactions. The Company pushes dozens of new features per year, often related to automation and other ways to boost productivity of its users. Despite this strong usage and support, Google has more recently de-emphasized monetizing Inboxes and shifted to less intrusive but more relevant forms of advertising. Further, Gmail is deeply integrated with other Google services, often serving as an onramp to those services. These services can also be monetized through subscriptions to Google Workspaces (formerly known as G Suite). We suspect Workspaces is positioned in the market to take share from more traditional productivity offerings like Microsoft 365. Admittedly, Alphabet discloses little financial details about Gmail. However, with 1.5 billion daily active users, we can compare it to other businesses that disclose active user counts. Twitter’s equity was recently valued at $44 billion and has around 240 million daily active users of the service as a forum to communicate, whereas advertisers and subscribers are Twitter’s primary sources of revenue. In lieu of any revenue, assets, or cash flow data about Gmail, we can estimate value using a similar market cap to daily user multiple. Using this multiple, the value of Gmail would be approaching $275 billion, which would be equivalent to about 20% of Alphabet's current market cap. Of course, we realize that using Twitter as a comparison is problematic, not least because the investor valuing Twitter at $44 billion has reportedly made the case that it is worth substantially less. Even if the comparable multiple ends up being half of what we used, the point is this: Gmail as an “other” business would still be worth over $135 billion. Disclosing more relevant financial data about this business line would go a long way towards driving a higher multiple for Alphabet.
Another one of Alphabet’s “other” business is Google Maps. Maps has more than 1 billion visitors per month and is deeply integrated into the Google’s core search services which helps facilitate more than 2 billion interactions between businesses and searchers per month.3 Businesses rely on these interactions to drive sales and brand awareness, particularly local businesses, when it comes to Maps. So, the value proposition of Maps not only helps to drive wallet share of ad budgets, but also helps expand the total addressable market for ad budgets by creating new revenue-generating experiences and opportunities, previously unavailable to other ad formats. For example, even businesses that do not have websites can be connected to customers because Maps serves up a phone number than can be directly dialed by a Google searcher on a smartphone. While many users take this function for granted, over 120 million businesses can rely on this to be connected to their customers.4
Other than the “other” businesses of Maps and Gmail, Alphabet’s Google Play is also another franchise. This other, other, “other” business might not be as well-known to Apple iOS users, but it is basically the Android-equivalent to the App Store and Apple Music. Google Play was launched roughly a decade ago, and Alphabet recently reported that over 2.5 billion people in 190 countries use the service every month.5 We can better size Google Play revenues than Maps or Gmail, because Alphabet offers an alternative form of segmentation in its filing, but again, the Company manages to declare Google Play revenues as “Google other” revenue along with hardware sales (Fitbit, Nest, Pixel phone, etc.), YouTube subscriptions and other (of course). As recent as 2021, we estimate Google Play revenues are 75% of Google Services’ “Google other” revenues, which means the business could be generating over $20 billion in revenues – up a third since pre-pandemic. We suspect these revenues have very little in the way of costs compared to Apple’s App Store, as Alphabet has mentioned that Google Play revenues are net of any pass-through revenues. Using an Apple-like 10% overhead expense and an Apple-like 20X trailing pre-tax multiple, Google Play could be worth close to $400 billion. Not bad for another other, other, other business.
As mentioned earlier, Alphabet grew its second quarter 2022 core search revenues +18% (foreign exchange adjusted) on a staggering +68% year ago comparison. Despite this stellar top-line performance, shares continued to sell off as the market discounted fears of a recession. Our multi-year time horizon and appreciation for the Company's “other” assets allows us to tolerate this exact kind of short-term volatility in growth rates (rather than implicitly extrapolating near-term slowing growth trends into perpetuity by selling). The past few years of economic activity and dramatic shift in company-specific drivers of growth have been unprecedented, so a “normalization” of end-market demand at Alphabet is certainly not the end of the world. In addition, Google Search has been less affected by disruptions related to Apple’s privacy initiatives thanks to the Company's long-term investment in the Android Mobile operating system. Alphabet’s Cloud segment is generating revenue at a $25 billion run rate but is still running at a loss. This business can generate much better margins at some point. In the meantime, the Company has a fortress balance sheet and has been repurchasing shares at attractive historical multiples. The Company could expand that multiple in a very low-risk manner, simply by disclosing more information about its “other” businesses that we think are clearly powerhouses in their own right.
From David Rolfe (Trades, Portfolio)'s Wedgewood Partners third-quarter 2022 shareholder letter.
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